Visit vanguard.com or contact your broker to obtain a Vanguard ETF or fund prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in Creation Unit aggregations. Instead, investors must buy or sell Vanguard ETF Shares in the secondary market with the assistance of a stockbroker. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss in a declining market.

Stocks of companies in emerging markets are generally more risky than stocks of companies in developed countries.

An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.

All investing is subject to risk, including possible loss of principal.

Recently, one of us (Maria) was at a bank trying to set up a small custodial IRA on behalf of a nephew and was told that “a minor can’t have an IRA.” It was an interesting experience, and one we think may be common. While an IRA may not make for an exciting birthday present for a teenager, it’s a good way to start investing at an early age. The conversation occurred about the same time we were working on our IRA Insights piece Now is the time to graduate to an IRA, and our research found that young investors, who have the most to gain from making a contribution, are contributing at a lower rate than their older counterparts.

According to our projections*, a 20-year-old investor who begins saving $200 per month in a Roth IRA, invested in a portfolio of 80% stocks and 20% bonds, would have about a 55% chance to accumulate over $1 million by age 65. On the other hand, if a 30-year-old investor follows the same program, the likelihood of being a millionaire drops to 14%.

The reason for this dramatic difference is that young investors have the opportunity to take advantage of compounding—the process where investments make returns, and those returns make returns, and so on. The more time you have, the more “so on’s” you can add to that sentence, and the bigger and bigger the potential returns get. The graph below shows how the wealth curve really begins to bend up as time goes on (using the same example as above)—especially as you get to 40 years and beyond. In our example, it takes 35 years for the median investor to get to half a million dollars. Then just 10 years for the next half-million. Then just 8 years to tack on another million.

“There‘s plenty of time.“ Well, maybe. But as we showed above, the time you have will never be more valuable than the time you have now. The fact that there is “plenty of time” is exactly the reason you should be investing now, instead of waiting for the future. Every dollar you invest now is a down payment on life options down the line.

“I‘m too young.“ Anyone with earned income can open a Roth IRA. That includes minors with a summer job (contrary to that bank teller’s questioning). At the extreme, some people even open IRAs for infants who have modeling income. The youngest IRA owner at Vanguard is less than one year old.

“I don‘t have the money.“ Perhaps you need every cent of income from your summer job to pay for college expenses. But every dollar matters—the example we used above was based on $50 per week. Windfalls like a tax refund or cash gifts from aunts, uncles, and grandparents are great sources of money for contributions. And some parents will even choose to match contributions that their children invest for the future rather than spend. Perhaps such an arrangement can work for you.

“I don‘t want to tie that money up where I can‘t get it. I might need it for an emergency.“ One good thing about choosing a Roth IRA is that the contributions that you make (although not the earnings) can be withdrawn at any time, for any reason. While we wouldn’t recommend using a Roth IRA as a place to store short-term savings, the money can be used in a pinch, and in the meantime you’ll be generating earnings that can continue to compound.

“I already have a 401(k).“ If you just got your first job with a company that offers a 401(k), congratulations! However, once you get past contributions that are matched by your employer, you might still want to consider a Roth IRA for saving additional money. This is especially true if your employer’s plan is filled with high-cost investment options, or if they don’t offer a Roth option for your 401(k) contributions. Later in life, you may be grateful for having “tax-diversified” with money in different kinds of accounts.

$1 millon sounds like a lot—and it is. But if you get started early, you may be surprised at how attainable it is.

*All results are in nominal dollars (not inflation-adjusted) and based on a portfolio invested in 80% U.S. stocks and 20% U.S. bonds. Median projected balances and other results generated by the Vanguard Capital Markets Model® regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time. The VCMM projections are based on a statistical analysis of historical data. The asset-return distributions shown in this paper are drawn from 10,000 VCMM simulations based on market data and other information available as of December 30, 2013. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.

Notes: All investing is subject to risk, including possible loss of principal.

Withdrawals from a Roth IRA are tax free if you are over age 59 1/2 and have held the account for at least five years; withdrawals taken prior to age 59-1/2 or five years may be subject to ordinary income tax or a 10% federal penalty tax, or both.

The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.

Maria Bruno

Maria A. Bruno is a senior investment analyst in our Investment Counseling & Research group. Her areas of expertise include portfolio construction and financial planning, with specialization in retirement planning topics, retirement income solutions, and wealth management strategies.
Prior to her current role, Maria worked in Vanguard's Personal Financial Planning and Advice Services departments. She has more than 20 years of experience in the financial services industry.
She earned a B.S.B.A. from Villanova University and holds the Certified Financial Planner™ certification.

Stephen Weber

Stephen Weber, CFP®, is an investment analyst in Vanguard Investment Strategy Group. Previously, he managed the design and implementation of software and internet applications related to financial planning, portfolio analysis, and portfolio monitoring. Stephen has more than 20 years of experience in the financial services industry. He has earned the CFP® certification and an M.B.A. and M.S.I.S. from The Pennsylvania State University.

Comments

Trevor M. | September 5, 2014 3:47 am

Let a married couple invest $530/month in an IRA, starting in the year they turn 23. Let the annual real rate of return on this IRA be 3.5%/year; I trust you agree that this assumption is very conservative. Let the monthly contribution increase by 3% at the turn of every year. At the end of the year they turn 63, the IRA will be wirth $930K. Let the couple retire and draw down the IRA by $3500/month. The IRA will not be exhausted until December of the year they turn 104. If meeting these payments proves difficult in the early years, they should ask their parents for help.

Edward S. | November 24, 2014 10:20 pm

You’re not figuring in inflation. It’s possible that an inflation rate of maybe 2% per year will mean that by the time the kids are approaching retirement the real value of their IRA will be much lower and $3500 a month might barely pay house expenses -leaving nothing for food. So even at age100 they might have to ask their parents for help.

H B. | December 31, 2014 4:15 pm

“Let a married couple invest $530/month in an IRA, starting in the year they turn 23. Let the annual real rate of return on this IRA be 3.5%/year; I trust you agree that this assumption is very conservative. Let the monthly contribution increase by 3% at the turn of every year. At the end of the year they turn 63, the IRA will be worth $930K. Let the couple retire and draw down the IRA by $3500/month. The IRA will not be exhausted until December of the year they turn 104. If meeting these payments proves difficult in the early years, they should ask their parents for help.”
————–
“Let the annual real rate of return on this IRA be 3.5%…” is the condition stated.

Doesn’t “real return” cover inflation?

————–

6% real for stocks and 4% for bonds were the returns for the USA and England for ~100+ years when they dominated. 3.5% would seem to be conservative.

Janet C. | August 27, 2014 10:18 am

The Author misses a critical point; the money put in a custodial IRA does not need to be the same money that the child earns. Grandma or Dad can drop their cash in the IRA, allowing the child to keep their babysitting money.

The parent can encourage savings by “matching” the part of the babysitting money that the child puts in the IRA, so long as the total does not exceed total earnings. The babysitting money would have to be declared as income, but showing a young child how much the government takes, and how it can be avoided by tax deferred contribution is a critical early lesson. My ten year old absolutely got it and now has become a 401(k) mavine in her first professional job after college.

Steven S. | August 11, 2014 5:30 pm

At an assumed inflation rate of 3.5%, one million dollars, 45 years from now, will only purchase $212,659 of “stuff”, in today’s dollars. The hypothetical 20 year old would need to accumulate $4,702,359 at age 65, to sustain the purchasing power of today’s $1,000,000. We haven’t seen average annual 3.5% inflation in a long time, but it’s certainly possible to see it return over the next 45 years. The hypothetical 20 year old would probably have to invest around $660 per month, and increase that amount annually by the rate of inflation, to have a reasonable chance of making his/her goal of $1,000,000 purchasing power in today’s dollars, 45 years from now. (All of the above figures are hypothetical and are not guaranteed.)

Steven,
This is a good point, and normally we put projections like this in “real” (inflation-adjusted) dollars, so people understand the purchasing power implications. For this piece, though, the million is more an aspirational number than it is a determination of “how much you’ll need,” so we chose to present the results using nominal dollars. If we had run this same example using inflation-adjusted dollars, the median projected balance in 45 years would have been just over $500,000. Alternately, we could have doubled the contribution assumption to $400 per month, and the probability of $1 million in real dollars would have been 51%. However, for young investors, the “million dollars may not be enough” message can be demotivating. Society can often make “a million dollars” seem unattainable, and it’s hard enough to get young investors to understand that it’s not. We’re hoping to get them to think about starting, and $200 a month seemed like an amount that might be considered reasonable. But if you can save more, then that’s great!

Paul D. | August 14, 2014 12:20 pm

Mr. Weber, I heartily agree!

The important aspect of reaching a goal is starting the journey as soon as possible. Rarely does the searcher describe the size of the buried treasure as much as he describes the search. In this case, it matters not which ‘dollars’ are being used, it matters most that the saving of these ‘dollars’ is begun soon and the habits of doing so repetitively becomes ingrained quickly…so as to become second nature rather than conscious effort.

The ‘treasure’ of a suitable retirement nest egg will appear in a future that has been structured on the discipline of saving. It may be millions or it may be something else, the saver will have learned to live within their means and still save. Two very important lessons for prospective retirees.

Steven S. | August 22, 2014 4:13 pm

Mr. Weber,

I apologize. In re-reading my post, I see that it might have sounded critical, and that wasn’t my intent. Paul D. said it much better than I did.

I was trying to make the point that young people must save early and often, and save more than is generally believed, in order to overcome the negative effects of long-term, compound inflation. It’s our job to instill such discipline in as many young people as we can possibly influence.

Just as Vanguard Charitable seeks to make giving a habit. It would be wonderful if Vanguard’s Government Affairs department could somehow work to introduce the importance of habitual savings to high school seniors all across the country.

Vic R. | August 7, 2014 7:24 pm

“$1 millon sounds like a lot—and it is. But if you get started early, you may be surprised at how attainable it is.”

It isn’t as much as you think, especially if it isn’t liquid (i.e., home equity). It should be enough now but by the time today’s twentysomethings are ready to retire they will need a whole lot more. Even more reason to start early and max contributions.

PAUL C. | August 7, 2014 4:16 pm

Right, we opened a ROTH for our now 15 year old in 2012 for tax year 2011 and our now 13 year old a year later. The local credit union does not have an account minimum so that is where we got started. It took until tax year 2013 for our oldest to deposit enough earned income in aggregate to transfer to a ROTH at Vanguard. Hopefully the younger one will reach the $1,000 threshold this tax year or next, then we’ll transfer the balance to a ROTH at Vanguard. Where, again hopefully, they will both experience a higher return rate and thus the power of compounding. By the way, the kids earn money from neighbors for pet care, plant watering, babysitting, yard work, etc. The really tough part is getting them to track their income!

Rachel D. | August 7, 2014 10:17 pm

Paul C – If your children like using technology and apps for their phone or tablet, then you might wish to have them use Mint.com. They can link in all of their accounts – checking, IRAs etc as well as add transactions like their earned income individually. It’s easy to do “on the fly”, tracks your spending for you on a daily basis, and the trending charts provide a great motivator or a reminder to reign in spending in a certain category. I wish that this app (or website if you’re using a laptop) had been around when I went to college…I would have balked at how much I was loading onto credit cards via international phone calls at a much earlier point if I had watched those bills add up month after month via the trending feature.

This is a well-written article. Although I cannot afford to invest more than I am, it has helped me to better understand how a millionaire can become a multi-millionaire so quickly as long as they tuck their savings away.

crazylyle | March 5, 2015 2:01 pm

The minimum investment limit prevented several of my kids from investing in mutual funds. We got around that by buying ETF shares. ETF shares have no (effective) minimum investment. Several of the brokerage firms have commission-free ETFs that are broad market indexes.

Anthony C. | August 7, 2014 3:09 pm

Maria,

Thanks for writing with such simplicity so everyone can understand how important is is to save, save early and save often. How can I possibly start a Roth IRA for my daughter whose only 4 years old. Is there other ways she can earn income besides modeling? I do have many friends that own businesses that could possibly use her in their advertisements. If she had earned income how does she file her tax forms? Any information on how to start a Roth IRA for her would be appreciated. It would be great if we could open a Roth IRA for our kids with our earned income. Has this ever been discussed in Washington? Thanks again for your writing and have a Blessed Day!

Stanley G. | August 9, 2014 2:01 pm

My Vanguard accounts are all traditional IRA accounts and total $350,000.
My income, via an annuity, is about $65,000. When adding the funds from the RMD and some earned interest, my taxable income totals about $87,000. I file my income tax as “single” with no dependents. I’m 84 years old and in good health..
Would it make financial sense to switch to a Roth IRA?
That question arises out of the fact that the tax I would pay based on the switch to a Roth would be large. In addition, my remaining lifetime is uncertain and the “switch”, therefore, may not be an advantage.
Do you have any thoughts about this matter?

Anthony, unfortunately, your daughter needs earned income to open an IRA, and her allowance doesn’t really count. It needs to be from a job or from self-employment (like baby-sitting). On the other hand, when she starts earning money, tax filing doesn’t normally become necessary for a minor until $6,100 of earned income (in 2014). As an alternative, in the short term, perhaps you could consider a Uniform Gifts to Minors Act account, although I suggest reviewing the link before doing so to make sure you’re comfortable with some of the account implications. Or you could segregate some of your own assets into a tax-efficient investment vehicle and gift it to your child at your discretion later on.

Sir K. | December 29, 2014 1:29 pm

My 10 year old is teaching Piano to me and his sibling. We pay him for the lessons. Does this count as self employment?

This is in reference to your comments below:
Anthony, unfortunately, your daughter needs earned income to open an IRA, and her allowance doesn’t really count. It needs to be from a job or from self-employment (like baby-sitting).

crazylyle | March 5, 2015 2:07 pm

There is no reason that “teaching Piano” cannot be self-employment. I have my daughter keep a running journal of how much she was paid, on what date and what for. Then at the end of the year, we total it up, and I put that much in her Roth. And just to be on the safe side, over Spring Break we file an income tax return for her, based on her recorded earnings. She doesn’t earn enough to actually have to pay taxes, but all the paper work is properly filed. (It even helped us find out and fix a problem with her Social Security number — they had the digits of her birth date reversed — when we tried to e-file the first time.)

Laura F. | August 7, 2014 2:49 pm

Great article and a strategy we’ve encouraged our kids to follow. We have matched contributions since they were teens and now, in their twenties, they are able to make contributions of their own. I only wish that Vanguard had more funds with a lower limit for the initial contribution. I encouraged my teenage niece to open a Roth IRA with Vanguard, only to find that they no longer have a fund with a $500 opening deposit. When I opened my kids’ accounts, the STAR fund had a minimum at that level, but no longer. It can be hard for many young earners with only summer or part-time income to amass $1000 in earnings, even if parents or relatives are willing to contribute the funds for the IRA.

Mary Lou P. | August 21, 2014 7:43 pm

Laura, I agree that it is unfortunate the VG no longer has any offerings with account minimums low enough for first-time investors. A number of other investment firms do better in this regard than VG. And if the kids start saving at, say, Schwab, what’s their motivation to switch later on to VG when they’ve got that $1000 – 3000 minimum?

Brian J. | August 23, 2014 7:19 am

It’s a difficult balance for me on this. The larger the minimum account balance, the lower the expense ratio will be for funds in general. To meet the mission of having extremely low expense ratios, we are going to see the minimum required balances slowly walk up over time. Administration of an account with $1000 is the same as with $10,000. Similar to a publicly traded company, it is in Vanguards interest to produce the best return (in this case lowest expense) possible for the majority of investors. However, perhaps a STARTER fund or something of that nature could be made with a lower entering minimum with a expense ratio to reflect that those accounts will be small and tie it into a index fund. This could be justified in that it is grooming future clients and the additional administrative costs are covered by that special funds elevated expense ratio. I can appreciate the need to teach young people (like myself) the need of saving, but not at the detriment to fixed income bond holders or the general population. Teaching is not the responsibility of a company.

Paul D. | July 31, 2014 9:24 am

Very well written Maria. I truly hope (and wish) more people will take your advice to heart.

Folks who are reading these blog posts are, at some level, already aware of their need to save and prepare for tomorrow. It’s the folks who haven’t a clue we really need to reach. These are the young people who will put a burger and fries on their credit card and then make the minimum payment on the card balance. Not knowing (or caring) that burger and fries will wind up costing them probably 10 times the amount they would have normally paid in cash because of interest charges. They would laugh at the idea of them ‘financing a burger and fries’ but that’s exactly what they do every time they charge something and don’t pay the full balance when it’s due.

These same people will one day be looking at their own retirement and the cupboards will be bare unless they learn soon to heed the save and live below your means call. I like to tell them a variation of the old Chicago voting adage….SAVE! SAVE EARLY AND SAVE OFTEN!

Steve L. | July 23, 2014 10:10 pm

re: “The reason for this dramatic difference is that young investors have the opportunity to take advantage of compounding—the process where investments make returns, and those returns make returns, and so on. The more time you have, the more “so on’s” you can add to that sentence, and the bigger and bigger the potential returns get. The graph below shows how the wealth curve really begins to bend up as time goes on (using the same example as above)—especially as you get to 40 years and beyond. In our example, it takes 35 years for the median investor to get to half a million dollars. Then just 10 years for the next half-million. Then just 8 years to tack on another million.”

Steve L. | July 23, 2014 10:07 pm

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At Vanguard, we’ve always believed in candid, direct communication with investors. In fact, it’s one of our core principles. In 2009, we created the Vanguard Blog so that we could talk about what’s happening in our industry and in the economy—and hear what’s on the minds of investors like you. More

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Visit vanguard.com or contact your broker to obtain a Vanguard ETF or fund prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in Creation Unit aggregations. Instead, investors must buy or sell Vanguard ETF Shares in the secondary market with the assistance of a stockbroker. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss in a declining market.

Stocks of companies in emerging markets are generally more risky than stocks of companies in developed countries.

An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.

All investing is subject to risk, including possible loss of principal.